The Trump rally looks to be fading, even as the presidency of Donald Trump begins. But if some investors have lost their enthusiasm for stocks following a postelection surge, not so the members of the Barron’s Roundtable. These nine market mavens confessed at our annual get-together, held on Jan. 9 in Manhattan, that they expect the major indexes to post muted gains, if any, in 2017, given today’s rich valuations and a likely rise in interest rates. But they insist the outlook for their picks couldn’t be brighter. That could be especially true if Trumponomics translates into lower tax rates for corporations, less burdensome regulations, and a more robust economy.
Last week, Barron’s featured the big-picture views of all our panelists—on equities, interest rates, economics, geopolitics, and more—and the specific investment recommendations of Zulauf Asset Management’s Felix Zulauf and Epoch Investment Partners’ William Priest. This week, we turn the mic over to Scott Black, Jeffrey Gundlach, Meryl Witmer, and Mario Gabelli, whose best bets for the new year range from commodity producers to auto-parts suppliers to closed-end funds to companies bearing the indelible fingerprints of yet another investment maestro, John Malone.
Scott, a numbers whiz who runs the show at Boston’s Delphi Management, favors companies with a high return on equity and lots of free cash flow, particularly if he can scoop up their shares at a discount.
Jeffrey calls himself “a bond guy who thinks about macro stuff,” which doesn’t begin to hint at the enormous success of DoubleLine Capital, the Los Angeles-based fixed-income firm he founded in 2009 and grew to more than $100 billion in assets.
Meryl, a general partner at New York’s Eagle Capital Partners, and a member of the Berkshire Hathaway (ticker: BRK.A) board, has earned a sterling reputation for uncovering value among lesser-known companies in unglamorous businesses, whose financials she masters better than any CFO.
Mario, head of Gabelli Funds and its parent firm, is a Wall Street legend, for good reason. He’s a shrewd thematic investor with a love of deals, an eye for steals, and an encyclopedic knowledge of multiple businesses and the people who built them.
To learn what this quartet likes now, please read on....
...Thanks, Scott. Let’s move on to Jeffrey.
Gundlach: One of the best indicators of the direction of bond yields is the ratio of copper prices to gold prices. It signaled the selloff in bonds that started in July. The copper/gold ratio has come down a little, which supports the recent bond rally. The yield on the 10-year Treasury got as high as 2.64% late last year, and has since fallen back to 2.37%. [Bond prices move inversely to yields.] We expect the yield to fall below 2.25%.Part 1, January 14:
Why is the ratio such a good indicator?
Gundlach: Copper is an industrial metal. A higher ratio suggests more manufacturing activity, and that implies an uptick in inflation and yields. As I explained this morning, I expect interest rates to rise later this year. One way to position yourself for further rate increases is to look for things that don’t have much interest-rate risk. Last year, I recommended the Brookfield Total Return fund [HTR], which invests in mortgage-backed securities. It was trading at a steep discount to net asset value. As luck would have it, it got merged into a new fund at its net asset value, producing a total return of 21.7% on a bond-like investment in a 2%-type year. This year, I am recommending something a little less juicy— Putnam Premier Income Trust [PPT], launched in February 1988. Its longevity is a good sign.
Putnam Premium Income is a one-stop-shopping, low-risk bond-portfolio investment with a decent yield. And it is trading at an 11% discount to net asset value. Unlike the Brookfield fund, there is little chance the price will rise sharply and converge with net asset value, as this closed-end fund has been hanging around with a 10% discount to NAV for a long time. Last year, the discount narrowed to 8%.
What are your return expectations?
Gundlach: You might get a capital gain of 3% this year, and the dividend yield is 6.3%. The portfolio is 80% invested in the U.S. The other 20% is a little spicy, and includes Greek, Russian, and Brazilian bonds. While the higher-risk holdings account for less than 10% of the portfolio, they are probably the source of much of the rich yield.
The duration of the fund is 0.3, according to Putnam, which means the fund holds allocations to assets, probably floating-rate or lower-credit securities, that dampen interest-rate-related volatility. But almost a third of the portfolio is invested in something liquid and easy to price: Fannie Mae mortgage-backed securities. Given the discount to NAV, you are buying Fannie Mae 3’s [the coupon is about 3%], basically the current coupon mortgage-backed security, at a price 11% below the actual market price, which translates to a yield about 150 basis points above market yields. It is an unequivocal bargain—kind of like buying a 10-year Treasury today at 4% instead of 2.37%. It is a great starting point.
Does the fund use leverage?
Gundlach: The Putnam fact sheet reports no leverage, but when I add up the numbers, leverage looks to be 20% to 25% of net assets. But leverage doesn’t increase your interest-rate risk because you don’t really have much risk. There is a small risk of your spread [between the yield on assets and the cost of borrowed funds used for leverage] shrinking. Maybe the fund is earning a 4% or 5% spread, which is contributing about a percentage point to the yield. If LIBOR [the London Interbank Offered Rate] goes up 100 basis points [one percentage point], you might lose 25 basis points on the yield. But you are still comfortably at 6% in a world where a total-bond-market index fund would have a net yield of around 2½%.The fund has about $600 million in assets. If someone wants to own one bond investment after this rally is over, this is a good one to have.
BKLN, or PowerShares Senior Loan Portfolio, is an exchange-traded fund. It holds bank loans, which have credit risk, but are at the top of the capital structure in bank debt. There isn’t a lot to worry about, even if oil prices fall. I agree with the consensus that oil will hang around the mid-$40s to high-$50s. Energy-company debt represents only 5% to 6% of the bank-loan market.
What does the fund yield?
Gundlach: It yields 4.1%. If you combine PPT and BKLN, you’ll have a 5%-plus yield and little interest-rate risk. Your total return for the year could be as high as 7% or 7.5%.
Next, like Felix, I would short German Bunds. They are yielding 0.27%, and Germany’s inflation rate is 1.7%. Historically, it is very rare to have a Bund yield below the inflation rate. The current gap is a record. The Bund yield is unsustainably low.
Schafer: What is the best way for an individual to short German Bunds?
Gundlach: Short the futures. I agree with Felix that the Italian bond market is deeply troubled. Shorting Italian bonds could potentially produce a massive home run; they are yielding 47 basis points less than 10-year U.S. Treasuries, which represents a full buy-in on the idea that the euro zone will last forever. If the euro zone breaks up, a possibility we have discussed, and Italy has to go it alone, sovereign bonds could yield 1.9%. The current yield is insanely low. But shorting German Bunds appeals more. They are more vulnerable at this point than U.S. bonds.
One argument for U.S. bonds when yields hit a low last July was that they yielded more than German Bunds, which had negative yields. In other words, U.S. bonds were better than something really terrible, but that didn’t make them good. Underlying the argument was the notion that German yields would stay negative forever. Well, forever lasted about a month. Since then, Treasury yields have risen more than German rates, but Bunds could underperform in the next leg of the bond bear market.
Zulauf:In 2012, there were widespread fears about the euro zone breaking apart. Back then, money flowed from the southern countries to the northern countries, and into Bunds. The next time the euro zone looks endangered, money will flow out of the euro completely and into another currency, primarily the U.S. dollar....MUCH MORE
Stocks Could Post Limited Gains in 2017 as Yields Rise